Cutting Taxes

What's happening?

Last Thursday, Republican leaders in the House put forward their tax plan. One week later, Republicans in the Senate did the same. Here's what those plans do—and what we should really be debating.

 

The plans have similar goals and generally follow the framework set forth by the Trump administration in September. Both would:

  1. Cut taxes on corporate income, which would also benefit wealthy people who earn a disproportionate percentage of their income from investments in stocks and dividends (i.e. capital gains)
  2. Reduce the tax rate for people making over around half a million per year, who are in the top income bracket
  3. Eliminate or reduce taxes on people inheriting over $5 million (the estate tax)
  4. Lower the rate on "pass-through companies" owned by individuals or families, like the Trump Organization

 

The House and Senate get there in different ways. For example, the Senate bill keeps seven tax brackets despite changing rates while the House bill strips them to four. The Senate plan also delays the cuts to the corporate tax rate until 2019.

Why is it important?

It's easy to get caught up in the important differences between these two bills, and the critical changes both would make to our current tax system. 

 

But let's take a step back for a minute. These two plans—in fact, major Republican plans since President Reagan's 1981 tax cuts—rests on one central claim: that cutting tax rates for corporations and high-income individuals creates jobs and increases wages for everyone. It's the basis for supply-side economic theory, sometimes called "trickle down" policies or "Reaganomics" (you'll see why).

 

This claim has shaped American tax reform for decades. Legislators began to slowly decrease the total number of tax brackets in the 1960's. In other words, based on the economic claim that it would benefit everyone, they removed the system that ensured the immensely wealthy paid a higher rate than the well-off. Most drastically, in the 1980s, President Reagan slashed the number of tax brackets to only two.

 

Today, we have seven brackets. The highest marginal rate is $39.6% for people making over $416,700, meaning everyone who earns more than that pays the same rate. This is what our tax brackets have looked like over the last 100 years, adjusted for a modern dollar value:

Debate it! 

Does cutting tax rates for corporations and high-income individuals create jobs and increase wages?

No: 

We have 40 years worth of data to show that these economic theories don't work. Plus smart business sense.

 

Republicans argue that with a lower tax rate a company has more profit left to re-invest, potentially expanding its business and hiring more people than it was before. But the track record of the American economy doesn't bear this out. (And the Laffer curve moved through pop culture before academia. It's a gross oversimplification of a complex system. There's no tidy arc.)

 

For the last 40 years, we have alternated between tax policies that increased taxes on corporations and high-income people and those that cut them. According to the Bureau of Labor and Statistics, income for middle-income households grew nearly twice as fast after tax increases than it did after tax decreases. Supply-side policies also resulted in higher national debt, which adversely affects the capital and debt markets to which businesses turn for funds to expand. The nonpartisan Congressional Research Service concluded in 2012, "The reduction in the top tax rates appears to be uncorrelated with saving, investment and productivity growth.” Look to Kansas, not Ireland, for a relevant example

 

And it makes sense. If there’s a larger market for a company's goods, why wouldn’t it expand regardless of its tax rate? It might not have as much cash on hand, but businesses don’t generally expand with retained earnings; they go to the capital or debt markets to get the funds, markets that suffer when tax cuts drive up the federal deficit. And if third parties won’t invest in the venture, why should we think it would succeed if they don’t? Finally, from a global perspective, US corporate tax rates don’t deter investment because the
aren’t actually high; the top marginal rate may be higher, but the effective rate actually paid after
deductions and credits is much lower than other countries with whom we compete for investment
. It's time we learned that the economic promises of tax cuts simply don't play out.

Yes: 

We need a low corporate tax rates to maintain a competitive economic environment for international business.  

 

The United States has the highest top corporate tax rate among advanced economies and the fourth-highest in the world, according to the Tax Foundation. Bringing it down to the proposed 20% in the House and Senate plans, for reference, would put it just under the 22.9% world average.

 

These corporate tax rates pose challenges for companies making business decisions about where to house their operations—operations that equal jobs, research and investment for American workers. High tax rates on individuals have a similar effect.

 

It makes sense that you can reduce taxes in a way that stimulates economic activity and actually raises total tax revenue—this is the Laffer effect. (The curve created by different tax rates and their resulting tax revenue is a Laffer curve.) Studies support a Laffer effect in corporate tax rates. In 2006, now-White House chief economist Kevin Hassett and his colleague, economist Aparna Mathur, analyzed data from 72 countries across 22 years and found "wages are significantly responsive to corporate taxation," specifically that a "1% increase in corporate tax rates is associated with nearly a 1% drop in wage rates." In a 2007 study, Hasset and a different colleague, Alex Brill, found a Laffer curve in corporate tax rates and identified 26% as the best corporate tax rate for stimulating economic activity and actually increasing tax revenue—significantly lower than we have now.

 

Europe offers relevant examples. Ireland has one of the twenty lowest corporate tax rates in the world, at 12.5%. The low rate has successfully attracted international business to the country—like Google and Apple subsidiaries, for example. One study found that if if Ireland changed its rate from 12.5% to 13.5%, "it would reduce the likelihood of companies choosing it as a location for foreign direct investment by 4.6%." We need to stay competitive, for everyone's benefit.

Learn more...

  1. The details of the House tax bill and of the Senate tax bill and the response
    • "Seventy-three percent of Americans, and 53 percent of Republicans, say they want corporate taxes either kept the same or raised, according to Pew Research Center polling. That the cuts are pared with some tax increases on individuals, like the elimination of the deduction for state and local income taxes and the Social Security Number requirement which kicks some 3 million kids off the child tax credit, makes the choice even more confounding."
  2. More on the Laffer curve—and the argument for why it's misguided
    • "There’s no reason to assume the relationship between tax revenue and tax rates is perfectly U-shaped. And the equilibrium point at which a government collects the most revenue possible without dragging down the economy is impossible to know—and varies by country. There was no reason in 1974—or, for that matter, now—to think the US was on the curve’s “prohibitive” half (many economists put the inflection point for the highest marginal tax rate at around 70%). In fact, without detailed data, you can’t tell where on Laffer’s curve (or non-curve) you are at all."
  3. 100 years of tax brackets, in one chart
    • "The US has historically taxed the very wealthy more than the somewhat wealthy — and way more than the middle class. In the 1960s, the tax brackets on the high end started to disappear, and during Ronald Reagan’s presidency we went down to just two brackets. That meant that many middle-class citizens were in the same tax bracket as millionaires."